There is always a cost to doing business and nowhere is this as true as in state and local taxation. Understanding tax requirements plays a crucial role in starting and running a successful business; bringing sufficient know-how to business decision-making should include well-informed tax planning, which affects areas as wide-ranging as the location of your entity and ensuring compliance with all applicable tax agencies to avoid running afoul of legal problems.
Each state and local jurisdiction has its own set of rules, which requires specialized knowledge on the part of business owners. However, an experienced tax professional retained to help prepare the business’ annual tax filings, or an outsourced accounting manager, can bring necessary understanding to keep a business operating smoothly and profitably, without taking up a business owner’s time or creating headaches attached to non-compliance that can hurt the business’ profitability and competitiveness.
While this article is not intended to outline state and local tax laws for every state or jurisdiction, it does establish some key points for understanding why tax strategy for business management is so crucial.
State and Local Taxes: A Business Management Perspective
States and local jurisdictions offer varying obligations when it comes to taxation. Lower tax rates may reflect a county’s interest in drawing business to an area, which can lead to greater ease when starting a new company, expanding existing businesses, investing in new equipment or new products and technologies, and expanding a workforce. On the other hand, higher tax rates can negatively impact innovation and profitability including the ability to pay dividends and other cost-cutting measures such as the size of the business’ workforce. Additionally, high tax rates on investment income such as capital gains and dividends may impact decision-making. Businesses seeking investment partners should be mindful of the environment created by state and local taxes and how attractive it may be to invest locally compared to in other areas with more favorable tax rates.
Effective budgeting for your business also means considering the role of state and local taxes. Understanding the amount and timing of your tax obligations will impact cash flow for your business, which affects other investments your business can make such as developing new products or services. The ability to innovate provides an advantage over competitors who don’t benefit from tax-favorable rates (such as tax incentives or deductions for research).
Finally, government investments in local infrastructure and education can play an indirect but real role in the success of your business. Tax revenues that contribute to improved access to public transportation, public safety and education can provide an environment that helps or hinders your business. Perceptions that your business operates in a safe community with a thriving, well-educated workforce and ready access to your location can contribute to the growth and profitability of your company.
Which Taxes Play a Role in the Success of My Business?
The above provides a high-level overview of the impact of state and local taxes on the growth, profitability and competitive potential of a business. Below is a brief overview of the actual taxes that can play a role in shaping the environment in which a business operates.
Business Income Tax
Income tax is the tax levied against the profits earned by a business. The business income tax rate is imposed by federal, state and local tax agencies, with variations at the state and local levels. (Federal tax rates based on business structure are described below). Some jurisdictions require estimated tax payments throughout the year based on projected income, which helps businesses avoid underpayment penalties at the end of each tax year.
Sales Tax
A sales tax is imposed by local and state governments during the sale of goods and services, typically as a percentage of the purchase price. This tax varies from one jurisdiction to another and will impact purchasing costs by consumers and their buying behaviors.
Property Tax
Property tax rates, like business income and sales tax, vary by jurisdiction. This tax, levied on real estate based on the assessed value of property, is used by governments for investments in public services and infrastructure. A word of caution about property tax is that assessment methods and the assessed value of a property can change occasionally, so staying current with a business liability is important as failure to pay can result in penalties, interest or even the loss of the property.
Taxation By Business Structure
Businesses can be structured differently, and each type affects how it is taxed. Sole proprietorships, partnerships, LLCs, C corporations and S corporations all have different tax advantages and disadvantages including different filing requirements. Choosing the most sensible structure for a business also means developing an understanding of associated tax requirements.
Excise Taxes
Unlike sales tax, excise taxes impact only certain goods such as gasoline or alcohol, as well as services that have an economic impact such as hotel reservations or car rentals. Political decision-making can also play a role in taxation such as the establishment of an excise tax imposed on environmental pollutants. Every business owner should be aware of state and local excise tax rules as well as their potential impact on the cost of the goods and services the business sells to consumers.
Inheritance and Estate Taxes
The death of a business owner will require a valuation of the entity for purposes of creating an accurate calculation of estate taxes. The tax obligations can be substantial and may impact an heir or beneficiary’s decision to keep or sell the business. Many jurisdictions offer estate tax exemptions or thresholds, which can offset significant financial obligations, and financial planning strategies such as asset gifting, may also minimize estate tax requirements.
Local Fees and Assessments
Finally, most businesses must also contend with fees and assessments by local governments for services, projects or infrastructure improvements. These fees are separate from other taxes and are often tied to specific properties and areas. Examples include utility fees, permit fees, impact fees, special assessments levied against businesses in a specific area or district to fund improvements for that area, as well as licensing and permit renewal fees. Business owners should carefully consider the jurisdictions in which their businesses operate to determine what obligations they could face for current or future projects.
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State and local taxes impact businesses in many ways as well as owners’ decision-making. CBM specializes in helping business owners understand their obligations, which can be especially valuable when each state and local jurisdiction has its own tax rates. Smart tax planning is a critical part of successful business management so be sure not to neglect this area where significant penalties and risks can be the cost of non-compliance.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.
